DUBAI — The draft law on public debt management, approved by the Federal National Council (FNC), is a milestone of paramount importance in the development of a modern capital market in the UAE and in the Gulf Region, an economic expert said.

By Abdul Basit

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Published: Wed 29 Dec 2010, 11:41 PM

Last updated: Mon 6 Apr 2015, 10:12 AM

The FNC on Tuesday passed two federal bills including the public debt in tune of Dh200 billion.

“Economic development has been impaired by the lack of a liquid debt and sukuk market and has limited the sophistication of financial institutions and investment management companies,” Dr Nasser Saidi, Chief Economist and Head of External Relations at DIFC Authority, told Khaleej Times.

Well-functioning and liquid fixed income security markets may contribute greatly to the efficiency and stability of financial intermediation and to economic growth in general in the UAE and the GCC, according to Dr Saidi.

He said the importance of developing domestic bond markets has been recognised since the Asian crisis of the mid 1990s and is also now part of an international effort initiated by the G8 in 2007.

Debt markets represent the leading channel of liquidity for governments, public companies, agencies and financial institutions in many advanced and emerging economies.

Developing a local currency fixed income market brings multiple benefits: stable access to capital, diversification of monetary policy instruments, creation of a yield curve for pricing financial assets and tailoring risk management tools, Dr Saidi said.

Major benefits

The benefits can be grouped such as countercyclical fiscal policy; financing infrastructure and development projects; conducting OMOs; monetary policy; and cornerstone of debt & sukuk market.

Countercyclical fiscal policy

A government that can access capital markets is better equipped to conduct fiscal policy to smooth the consequences of economic cycles and (in our part of the world) in response to fluctuations of oil prices. Liquid fixed income securities markets allow a wider diversification in the supply of funding for the whole economy, thereby offering protection from a sudden withdrawal of capital or credit crunch.

Even governments with a healthy long-term financial position would benefit from the creation of a debt market to smooth business cycle fluctuations through a fiscal stimulus.

The GCC countries are investing heavily in infrastructure, which requires trillion of dollars financing. The MENA and specifically the GCC region have been highly dependent on banks to finance its long-term projects. Bond financing has been rarely used, in large part, because until very recently, they were deemed unnecessary in a region flush with capital and hydrocarbon wealth.

Conducting OMOs, monetary policy

The current peg to the US dollar does not give the GCC central banks much leeway to conduct an independent monetary policy. One of the positive externalities that accompany a domestic bond market is its ability to act as a tool for monetary policy and liquidity management. It makes open market operations feasible: simply put, buying government securities injects liquidity while selling securities withdraws liquidity.

Cornerstone of debt

and Sukuk market

In most countries, the debt market is born out of the need to finance government expenditures. With time, the yield curve on public debt becomes a reference for private entities such as banks, public utilities and corporations, which are then able to tap the market to fund their investments. In other words the public debt markets become the catalyst for the development of all fixed income securities and of Islamic securities.

A liquid and deep government bond market should encourage the development of a secondary market among life insurances, asset managers and international institutional investors.

abdulbasit@khaleejtimes.com